In my previous blog (see Cutting through the Fog of Freight Rate Predictions), I described the many factors that influence the movement of full truckload freight rates, and showed how historical data indicates that over time rates are headed north. In this second piece, I’d like to offer some insights into how often carrier contracts should be reviewed in light of the market’s inherent unpredictability.
First, let us review how the market performed during the first half of 2010. During the first quarter of 2010, we actually saw rates continue their downward spiral. The Stephens index (that uses publicly available information from carrier 10Q’s showing the average loaded RPM without fuel) showed that the average loaded RPM went down 3.15% year-over-year (YOY) even as the spot market started to heat up. The second quarter was a different story. After five consecutive quarters of YOY decreases in rates, we saw our first increase, and there continues to be tightness in the spot market although some indexes indicate that this market has cooled off some in July.
Hopefully, you managed to navigate these freight rate movements cost effectively; for some shippers, this is a difficult feat. The reason is fairly straightforward: the misguided belief that the best way to secure low rates is to lock them in for a period of, say, two years.
This is ill-advised for two reasons. First, please refer back to my last blog where I explained how the general tendency is for freight rates to nudge upward over time. In fact, over 20% of the time during a two-year period the YOY increase is likely to be over 10% and in excess of 58% of the time increases are more than 2.5%. (see figure below). This creates a bimodal distribution. Since a typical carrier after tax operating profit is less than 2.5%, it can be seen that committing to a rate for two years will almost certainly pitch a trucking company into the red. Such an outcome is untenable for both parties.
The second problem is that, in the volatile freight market, distribution networks that are in synch when a contract is signed and sealed will, at some point, be knocked out of alignment. If there are no corrections for two years, the misalignment can become a yawning gap. For example, Carrier A is contracted at a below-market rate to ship your freight from Boston to Atlanta. The carrier loses customers in Atlanta and all of a sudden does not want to serve that city. But, there are eight other carriers that do a lot of business in Atlanta and would welcome your freight. Except that your two-year agreement with Carrier A still has a long way to run.
The bottom line is that it makes sense to align your freight with carriers annually. It might be that Carrier A wins the same volumes, but allocated to a different mix of lanes that suites its reconfigured distribution network. Two years is simply too long to wait to make the necessary readjustments that keep respective networks aligned.
The situation is analogous to investing in the financial markets. Every investor expects the markets to fluctuate and rebalances his or her investment portfolio to allow for these movements. In much the same way, shippers have to tweak their networks to correct for changes in the freight market.
The secret is to formulate a plan for a yearly Strategic Procurement Alignment and to stick with it. Not only will you develop a robust process for contracting freight, you will build credibility in the market as a reliable, even-handed customer. And in these uncertain times, such a reputation is worth a great deal.